Legal Updates

With the Insurance Bill 2015 being granted royal assent earlier this year, the insurance industry has been scrambling to ensure it is well-prepared for the changes that will occur in UK insurance contract law, especially since it is to replace the 109-year-old Marine Insurance Act 1906. The Insurance Act will come into force in August 2016.

There has been much commentary on the pivotal variations to contract wordings, but little has been said about the new risks for brokers in terms of what is expected of them. This is particularly significant because in these soft market conditions, with insurers taking a more stringent approach to claims management, brokers have increasingly become the target for negligence claims. Often, insureds are likely to seek to recover their losses where Insurers have avoided cover or exercised a policy right to limit their liability. This article will explore the impact that the Insurance Act 2015 will have on brokers, and will offer guidance for brokers in the context of key case law.

1. Insurance Act changes

The key changes that the Insurance Act will bring about can be categorised into three areas: a) presentation of the risk; b) warranties; and c) proportionate remedies. To draw out the impact that this will have on insurance brokers, each area will be dealt with in turn.

2. Duty of Fair Presentation

The Act establishes a new concept of “fair presentation” of the risk in place of the previous duty of disclosure. The insured/policyholder will have a duty to:

Disclose to insurers “every material circumstance” which it “knows or ought to know”, or failing that provide “sufficient information to put a prudent insurer on notice that it needs to make further enquiries for the purpose of revealing those material circumstances”.

Disclose information in a manner that would be “reasonably clear” and “accessible to a prudent insurer”.

The first of these two criteria can be considered to represent a diluted version of the current obligation to disclose all material circumstances which are known or ought to be known by the insured.

In contrast, the second requirement is new. The inevitable impact is that the broker will have to provide an extra layer of advice to ensure the information is in the correct form. This could potentially be problematic in the scenario where an insured has provided large amounts of irrelevant information to a broker that obscures something material, and does not have the time to filter through.

In these circumstances a broker will have to either filter through the information themselves (which is a risky option), or disclose the information in the knowledge that there is a risk of it falling short of the requirement. Upon such events, a broker should be prompted to shift the burden back to the client to provide the information needed via a warning to the client, which may impact the commercial relationship. Brokers need to be cautious about the content of such a warning as the case of Nicholas G Jones v Environcom Limited and MS PLC t/a Miles Smith Insurance Brokers (third party) [2010] EWHC 759 (Comm) establishes.

2.1 Jones v Environcom

At this juncture it is useful to expand upon this case in the context of the Insurance Act 2015, as it helpfully clarified the broker’s duty to explain to clients their disclosure obligations.

In this case Environcom, who operated an electrical goods waste facility, used plasma cutters at very high temperatures to remove difficult bolts from refrigerators that contained pentane, an extremely flammable substance. Environcom failed to report several other smaller previous fires, and claimed on 16 September 2007 for a fire that destroyed their business premises. The source of ignition was likely the plasma cutter, and so Insurers rejected the claim on the grounds of non-disclosure of the earlier fires and use of the plasma cutters. Environcom settled with Insurers for £950,000 and pursued its broker, Miles Smith, for the £6,000,000 shortfall on the grounds that they negligently failed to advise them of their disclosure obligations, and made insufficient inquiries to discover previous fires and use of plasma cutters.

The court held that that a broker must:

Advise clients of their duty to disclose all material circumstances (and not simply rely on written standard form explanations, such as proposal forms, but enter into specific verbal or written exchanges on the subject to ensure that it is adequately explained);

Explain the consequences of failure to disclose;

Indicate the sort of matters that ought to be disclosed as being material (or arguably material); and

Take reasonable care to elicit matters which clients ought to disclose but might consider unnecessary to mention.

The crucial finding of the judgement was that when a broker is making inquiries to elicit material information, a higher standard of care may apply if the broker has not adequately advised their client of its disclosure obligations. The broker in this case had no duty to inquire about the use of plasma cutters (technical knowledge of client’s business), but it was negligent in not inquiring about fires or advising the insured to disclose fires (an insured peril). Additionally it was held that the broker could not rely on written standard form explanations that the disclosure obligations have been properly explained.

Therefore in the context of the new Insurance Act 2015 duty to make a fair presentation of risk, the broker should ensure that they bear those principles in mind.

2.2 Easing of broker’s duties? – Eurokey v Giles

Before moving on to the next section, it is important that we turn to the case of Eurokey Recycling Ltd v Giles Insurance Brokers Ltd [2014] EWHC 2989 (Comm), where the court appeared to reverse the trend of brokers’ duties becoming more onerous with each reported case.

In this case the broker, Giles, placed insurance cover for Eurokey in respect of its waste recycling plants. The cover included business interruption and was obtained on the basis of turnover of £11,000,000. In reality, the turnover was £17,600,000, so accordingly the business interruption cover should have been higher. Eurokey was severely under-insured and when a fire occurred, Eurokey obtained a relatively low settlement with the insurer. This led to the familiar scenario where they sought to recover the shortfall in negligence from the broker.

The court dismissed the claim against the broker entirely, which was a good result for brokers. However, the court still reiterated the principles that should guide a broker, namely that a broker cannot be expected to conduct a detailed investigation into the client’s business. This reinforces the view set out in Jones v Environcom, although the broker must still take reasonable steps to ascertain the nature of the client’s business and their insurance needs.

Whilst the broker’s duty remains high, it is now clear that a client cannot work on the assumption that the broker will understand the client’s business for insurance purposes. Specifically:

A broker is not expected to carry out a detailed investigation into a client's business;

The sophistication of the client is important. However, this will be case specific. It cannot be assumed that a small or medium-sized enterprise will have any understanding of insurance. In this case, the broker was considered to have given sufficient guidance for a relatively sophisticated client;

The burden is on the broker to demonstrate what advice it has given. Brokers must therefore keep written records of such advice where possible; and

A broker is not expected to verify information provided by a well informed client unless he has reason to believe it is not accurate.

3. Warranties

The theme in relation to this element is that of a continuing duty on the part of the broker. The Act seeks to abolish the previous draconian approach to warranties in favour of a more flexible approach. In other words, a breach of a warranty will no longer automatically discharge the insurer from liability from the date of that breach. Instead liability will be ‘suspended’ for the duration of the breach, allowing the insured to possibly remedy the breach, and cover to continue following that remedy.

The changes in the law arguably impose a further duty on the broker to warn an insured if they have discovered mid-term that a warranty is being breached, but do not advise the insured to remedy that breach. In that scenario, if an insurer was to later reject a claim under the policy due to the breach and the insured considers the advice it received from the broker, it could find that the broker should have warned them. This differs from the current law where a broker would simply defend itself by establishing that they gave appropriate advice at policy inception, making the failure to advise later irrelevant (since the breach is fatal to cover as soon as it occurs). However, under the Act, this argument is invalid since the breach could have been remedied.

4. Remedies

In line with the theme of a continuing duty for the broker, the amendments to the application of proportionate remedies are potentially problematic. The Act seeks to introduce an alternative remedial option for insurers, rather than solely policy avoidance.

The issue of proportionate remedies will arise where there has been a breach of the duty to provide a fair presentation of the risk which is “neither deliberate nor reckless”. The possible remedies available are:

Not to have entered the contract at all;

To have entered into the contract on different terms; or

To have charged a different premium.

The last two remedies present additional risks for the broker, since they will often be asked to play a part in the process of advising the insured in their discussions with the insurer to decide which remedy should apply. In such scenarios it is quite possible that a broker’s advice on how to approach one particular claim might adversely affect the insured later. Therefore it is crucial that brokers carefully weigh up the options, and provide well balanced advice.

Once again, the duty of the broker continues beyond the application of the remedy. Brokers will be required to give advice on how the application of the remedy will impact on policy coverage going forward, and whether it still meets the client’s needs.

5. Summary

Overall, having highlighted the interplay between Jones v Environcom,Eurokey v Giles and the Insurance Act 2015, we can see a theme emerging in the form of a clearer shift to more continual involvement of the broker. As such, brokers will need to ensure that they are alert to the continuing duties that may arise, and the potential risks and issues as highlighted.

Stanley Kamalu

Trainee Solictor

Clarkslegal, specialist Construction lawyers in London, Reading and throughout the Thames Valley.

For further information about this or any other Construction matter please contact Clarkslegal's construction team by email at constructionsector@clarkslegal.com by telephone 020 7539 8000 (London office), 0118 958 5321 (Reading office) or by completing the form on this page.